Cash vs. Accrual
Generally, there are two methods under which you can do your accounting; the cash method and the accrual method.
The cash method of accounting is focused on the inflows and outflows of cash. Much like your personal finances, organizations have revenue when we make a deposit and incur an expense when we cut a check. There is little regard to when the revenue was actually earned or the expense was actually incurred, we just worry about the cash flows.
The accrual method of accounting doesn't worry about cash flow and instead focuses on when revenue was actually earned and when expenses where actually incurred. For example, let's say you purchase office supplies in the month of April on your credit card and pay for the purchase in May when you receive the credit card bill. Under the accrual method of accounting we would record the expense for supplies in April.
The other main difference between the two methods is the ability to budget accurately. Accrual method of accounting allows for better budgeting and planning because it looks at when liabilities are incurred and revenue earned and not when cash is paid. This method puts on the books liabilities that might otherwise be forgotten, like accrued vacation. The cash method doesn't worry about accrued vacation until it is required to be paid. This could create a very painful situation for a nonprofit that hasn't planned to pay out an accrued vacation balance and is now faced with cutting expenses in other areas to have enough cash to pay the outstanding balance.
Which Method to Use
The cash method of accounting is the easiest method, but not necessarily the most accurate. If you have paid staff you should not use the cash method of accounting. Be sure to check your state regulations. Some states require the accrual method of accounting to be used. The cash method of accounting is best used by very small nonprofits with no paid staff, no set programs, and little to no plans for expansion.
The accrual method of accounting should be used by organizations starting out with larger amounts of funding, paid staff, and plans to raise additional funds from larger donors such as foundations or government entities. Generally accepted accounting principles also require the use of the accrual method of accounting. If you wish to have an audit done under generally accepted accounting principles you should use the accrual method of accounting.
See also: Basic Accrual Concepts